Abstract

This note emphasizes the special role of prospect theory in drawing
psychophysical considerations into theories of decision making with
respect to risk. An example of such a consideration is the dependence of
outcome value on a reference point and the increased sensitivity of loss
relative to gain (i.e., loss aversion). Loss aversion can explain the St.
Petersburg paradox without requiring concave utility, it has the correct
psychological foundation, it is theoretically useful, and it is a parsimonious
principle that can explain many puzzles. A few open questions are
whether loss aversion is a stable feature of preference, whether it is an
expression of fear, and what are its properties.